How to use VCTs to boost income

Albion Ventures’ Patrick Reeve explains how VCTs can be a good strategy for retirement income.

The 2010/11 venture capital trust (VCT) fundraising season was a success, raising £365m – a 6% increase on last year. With so many attractive investment opportunities presently available to VCT managers, a clear investor appetite and a firm commitment to the VCT structure in the last Budget, many providers have extended their fundraising period to accommodate the increased demand.

And all this in a sector that, despite VCTs’ well-recognised contribution to job creation in the UK, had been rumoured to be out of favour with the government.

VCT investors tend to be high earners with substantial savings and investment portfolios who consider VCTs a long-term investment suitable for retirement planning. But for those who are not presently invested in VCTs and are considering retirement income strategies, what benefits can VCTs offer them as a pension top-up?

Pension problems

We are in the midst of ‘year one’ for baby boomer generation retirees and during the next 12 years a sizeable proportion of the UK population will be retiring. For anyone in the 53-year old to 65-year old bracket, retirement planning is a priority and retirement income, an issue.

The average single annuity rate for a 65-year old is presently around 6.72%.  With life expectancies for baby boomers exceeding those of the generation that preceded them and with bond yields falling, annuity rates – despite a rise in the three months to March 2011 – are expected to fall as well. Further concerns for pension income include inflationary increases that eat into the value of any income received, as well as recent changes to pension regulations that include limits to the size of a pension pot and tapered tax relief for earners of over £150,000 per annum.

Conversations with advisers and clients provide a clear message: investors want predictable levels of attractive income. Typically, financial advisers would look to equity income or bond funds to provide additional income, but yields are presently low. And in the case of equity income funds investing across a number of equity income funds that overlap on many stocks, portfolio diversification can be reduced.

How VCTs can help

Firstly, it should be stated that VCTs are not low risk investments and the question of risk and suitability will differ from investor to investor; this is a discussion for advisers to have with their clients. Certainly we would not suggest VCTs are suitable for everyone. However, VCTs do offer investors a number of benefits that make them eligible for consideration as a pension top-up, including an attractive tax-free income stream and portfolio diversification.

The diversification benefits of VCTs derive from their investments in unquoted companies, but equally their portfolios tend to be highly diversified, with up to 50 individual holdings across a number of different sectors. However, when an investor is seeking income it is the dividend stream that will prove most attractive.